Money: Avoiding a life sentence

Peter Rodgers on how to force insurers to keep their promises

It took a great deal of pressure to persuade the life insurance industry to begin disclosure last year of the effect of charges and surrender penalties on the performance of endowments and pension plans.

Using this information, the Independent last month published league tables of companies' performance based on work by John Chapman, a former senior official at the Office of Fair Trading, who before he retired wrote many hard-hitting reports on the life insurance industry.

The tables are the best method yet devised for assessing whether the products a company is offering are good, bad or indifferent. But Mr Chapman believes much more needs to be done to make sure life insurance companies deliver the performance they promise.

The Independent's rankings show a company's past performance and its projections of future returns. They are based on the fact that charges and surrender penalties, rather than investment performance, are the most important determinant of a policy's value.

The tables give a ranking from A+ to C- for a policy's past performance at three stages - when it is surrendered early, part-way through its life or at maturity. The same rankings are repeated using the company's own projections of future performance. It turns out that only a handful of companies can back their projections of good future performance with a comforting track-record of good payouts in the past.

Many others (see table) are projecting a future performance considerably better than in the past across a range of products. Clearly, they are asking customers to take on trust the claim that they have transformed their performance. There are several possible explanations. Companies may have had a disastrous investment performance that undermined past results. They may have achieved much bigger cost reductions than the rest of the industry. Or they may be borrowing from their reserves of free assets to subsidise new products and make them look better in the marketplace.

Another possibility is that somemay be taking advantage of flexibility in the disclosure regulations, in effect by introducing new charges later on to bump up their income from customers. One loophole is that where actual charges on a with-profits policy turn out to be higher than those a company projected when it sold the product (after making allowances for inflation), it is allowed to compensate by adjusting the bonus rates downwards.

This amounts to imposing a new surrender penalty not included in the projections made when the policy was sold. The Personal Investment Authority, the watchdog, defends this on the grounds that with-profits policies should be treated the same way as unit-linked policies, which are allowed to increase charges. The theory is that without freedom to raise charges, unforeseen events could drive the life insurer into insolvency. This threat is so remote as to be irrelevant.

According to Mr Chapman, about two-thirds of the costs to a company of running a policy are for commissions and marketing. These are short-term and predictable. Other costs, such as overheads, administration, life cover and fund management fees, are much lower, and also largely controllable. It seems highly improbable that unforeseen changes could drive a life company to the wall, says Mr Chapman.

When it comes to checking whether companies are raising their charges secretly, breaking faith with their customers, with-profits life insurance policies are particularly hard to deal with. With-profits policies are notoriously one-sided contracts, because the company has enormous discretion in setting bonus rates. Furthermore, there is no data published on the individual charges made for with-profits policies.

Some companies certainly consider that their actual future payouts should closely follow the charges assumed in their projections at the time the policies were sold. Companies where the marketing director carries more weight than the actuary may believe the projections are largely illustrative, and they rely on the discreet imposition of extra charges or penalties later in the life of a policy to improve their profits.

So why not force them to declare the assumptions about charges, which they must anyway make in private to calculate their projected bonuses and payouts? It would then be possible, by combining the data with actual figures for investment performance, to spot attempts to raise charges beyond the levels projected when the policies were sold.

This would not be a straightforward exercise, since allowance would have to be made for the convention of smoothing returns over a number of years. It would be rather easier with unit-linked policies to make these checks about whether promises are kept because more detail is disclosed already about charges.

But in both cases, it would be hard for an individual policyholder to assess whether he or she had been treated honestly, without expert help. One solution would be for policyholder committees to be formed for each company to look at these issues and report on whether the promises have been kept.

Companies promising better performance than they have delivered in the past

Legal & General Scottish Amicable Scottish Widows

past performance / projections

Products

10 year WP endowment CAB / BAA+ BCC / BAA BBB / A+AB

10 year UL plan ACB / BAA AAB / BBB BAC / AAB

25 year WP endowment CAA / BAB CCC / BAA BBB / A+AB

25 year UL plan na / BBA na / BBA na / A+AA

Single premium WP bond na / C-CC na / XXX na / AAA

Single premium UL bond BB / BBB BB / BBB CB / BAA

Flexible UL whole life na C-C A+A+

Regular premium WP pensions CBC / BAC CBB / BAB BCB / ABB

Regular premium UL pensions C-C / BAA BB / BBB XB / ABA

Stand alone WP pensions CBA / BBC BBB / AA+A+ CBA / ABA

Stand alone UL pensions CC / BBA BB / BAB CB / BBA

Executive pensions WP regular premium BCC- / BBC BCC / BBA+ CBB / ABB

Executive pensions UL regular premium CC / BAA BB / BBB AC / ABB

Executive pensions WP stand alone BCB / BBC BAC / BA+A+ BAA / BBB

Executive pensions UL stand alone CC / BAA BB / BAB CB / BAB

Number of products

Projections better than past 8 8 11

Projections worst than past 1 1 1

Flexible unit linked whole life policies are new and there are no comparisons

WP = with profit. UL = unit linked. NA = not applicable. X = no data

Products are ranked from A+ (very good) to C- (very poor). The first three letters for each ranking refer to actual past performance, with the first based on policy values at early surrender, the second at mid term surrender and the third at maturity. The second three letters refer to the company's own projections of future values.